As mentioned in the thesis statement, Income Statement is an account showing different monetary transactions in the company during any financial year. Having money is a great feeling but keeping an account of it is wise. As Max Beerbohm says, “Everyone, even the richest and most munificent of men, pays by cheque more light-heartedly than he pays little in specie.” (Beerbohm). In earlier days, people used to keep record of their monetary transactions in ledgers and passbooks. Then there was an awareness of banking. People started getting used to the banking system. Gradually the system of accounting became mandatory for all financial institutions and businesses. Separate government departments were created to monitor the transactions of all sorts of businesses. Owing to the huge transaction details, it was not feasible to keep a check on each and every detail. But “Income statement” is such an instrument which depicts all the details of a company. Any individual, who wants to know about the working of a company, has to simply study the “Income statement” and the complete financial details will be in front of him. Earlier it was also known as “profit and loss account”. Following is an example of a typical Income Statement.
|Income Statement for the year 2010-11|
|Cost of sales||25,787,910.00|
|Income before taxation||16,722,262.00|
An “Income statement” reveals the outcome of the workings or operations of a company over a period of time. It is called by various other names, such as, “profit and loss account”, “earnings report”, “financial statement”, etc. It shows the level of performance of a company. It is sort of a report card in which the capability of the management is revealed. There is a fixed terminology for certain terms in an “Income statement”. Terms like revenue or sales, expenses, gross profit, general expenses, interest, taxes, income before taxation and net profit are generally used in an “Income statement”. Revenue or sales is generally taken into accounting once the product or service has been delivered. The receipt of payment is not referred. Likewise, expenses that have not yet been made but the provision for which has been made, are also included in the “Income statement”. There is a simple theory which can tell us whether the company is making profit or is in loss. If the expenses are more than the revenue or the sales, the company is in loss and vice versa, if the expenses are less than the revenue or the sales, the company is making some profit. In certain cases, the depreciation on moveable and immoveable properties is also taken into consideration. “Income statements” of sole proprietors, partnership firms and big corporate houses depict similar kind of details. But there is one small difference. It is mandatory for the corporate houses to depict the earnings per share also. Earnings per share depict the amount earned by a single share.
Importance of the study
The importance of the study is that we come to understand the complete procedure, the ins and outs, the advantages and disadvantages of an “Income statement”. In my opinion there are two different categories of people who can benefit from the Income statement.
- The management: If there are two or more sources of income, it will clearly depict which one is generating more income. Efforts can be made to increase the sales of the other one. If the “Cost of sales” and “Expenses” are on the higher side, they can be reduced by taking certain measures. Hence the “Net profit” can be increased. It also helps the management to fulfill their commitment to report their company’s progress.
- The investors: Before applying for shares of any particular company, investors can go through the “Income statement” and see if investing in that particular company would be wise or not. They need not refer to the balance sheet or cash flow statements. Sincere investors, who have an in-depth knowledge of accounting also, can understand much more than simply the earnings of a particular company. They come to know about the management’s effectiveness in harnessing the income and expenditure resources of the company. Income statement also enables them to compare two or more companies on the ground of profitability.
Aim/s of the study
The main aim of the study is to understand how an “Income statement” is prepared, what factors have to be included, how can it be beneficial and what are the disadvantages if any particular company doesn’t have an “Income statement”. According to Harry Eisenberg, “If they have not issued a financial statement, that’s a company to stay away from. You can’t do any evaluation without looking at assets and revenues.” (Eisenberg).
The body of the study
Taking into consideration the sample table detailed above, the terms are explained as under:
The first entry in any Income Statement is always “Net sales” (or total sales or total revenue). This is the amount that comes in the company by way of sales of its products or service. But this is not the profit. This is only the money that has come in. But this amount is very important. This is because some overhead expenses are fixed. So in order to have more profit, the incoming money should be more. In the given example, the “Net sales” is 43,556,879.00.
“Cost of sales” is the expenses involved in bringing out the final product. This includes mainly the cost of raw material. In the given example, the “Cost of sales” is 25,787,910.00.
“Gross profit” is the figure arrived by simply deducting the cost of sales from the net sales. In the given example, this figure is 17,768,969.00.
The “Expenses” column holds most of the expenses like transportation, salaries, commissions, consumer bills, etc. These expenses play a vital role in the profit making of the company. Benjamin Franklin has rightly said, “Beware of the little expenses; a small leak will sink a great ship.” (Franklin). In the given example, the figure is 5,987,143.00. This head plays a major role in the generation of profits. Some of the expenses that come under this head are as under:
- General and Administrative: These are the costs related to the functioning of the company. Such expenses are not directly related to the cost of manufacturing or procuring the product. The management should ensure that such expenses are kept as low as possible.
- Sales and marketing: This cost is also not directly related to the manufacture or procurement of the products. But the management should be vigilant enough so that the cost doesn’t shoot up. Comparing such costs to those of similar companies can help the management in keeping a track.
- Research and development: This is a very important department in any company which wants to grow. Today, people look for improvement in all walks of life. Even in the products that they use. So unless a company is always on the move to improve its products or develop some innovative product, it cannot flourish. Hence this department is a must. The costs involved here are indispensible but keeping a check is a must. Many people, in the past, have supported the research and development department in any company. But I liked the views of Donald Evans, “We are the number one economy in the world, and we ought to continue to pursue those kinds of policies that ensure that we maintain that position, like innovation and like technology and like education and like just research and development and discovery.” (Evans)
“Interest” is the amount that the company has paid on loans from banks or other financial institutions. “Interest” is a very crucial entry because by deducting this, the liable tax is less. The authors of Graham and Dodd’s security analysis have expressed their similar views, “The absence of the interest expense results in immediately higher reported income and higher taxable income.” (Graham et al 219). In the given example, this amount is 59,564.00.
“Income before taxation” is the figure arrived after deducting the “Expenses” and “Interest” from the “Gross profit”. In the given example, the figure is 16,722,262.00.
Then there are different kinds of “Taxes” like income tax, sales tax, value added tax, etc., that the companies have to pay to the government. In the given example, the amount is 5,967,561.00. Different countries have different tax structures.
Finally, the “Net profit” figure is arrived by deducting the “Taxation” amount from the “Income before taxation”. In the given example, the final figure is 10,754,701.00.
Advantages and disadvantages
“Income statement” is a very crucial document for any business establishment. There are only advantages and no disadvantage (except a minor one that shall be discussed later in the paper) in having one. But if any company doesn’t have an “Income statement”, then there are only disadvantages and no advantage.
Advantages: One of the major advantages of having an “Income statement” is that it reveals profitability of any particular company. The company can concentrate on improving the weaker or loss making departments. It also shows the expenses incurred to earn that much profit. The ratio is very important for the management. Investors and shareholders are also benefitted because they can calculate the dividend being paid on the shares. Apart from this, there is another advantage. If a company approaches any bank or financial institution for loan, the first thing required is the “Income statement”. Better the “Income statement”, better will be the offer from the bank or financial institution.
Disadvantages: As such there is no disadvantage in having an “Income statement”, except a minor one. Suppose a company is in losses, the same shall be reflected in the “Income statement”. This may hamper the company’s plans to take any loan. This is because banks and financial institutions will never want to invest in a company which is in loss. The banks or financial institutions have to see whether the company will be able to generate the required income (for repayment of loan) and sustain as well. But on the contrary, if a company doesn’t have an “Income statement, there are of course certain disadvantages. First of all, the management will not know as to which way the company is heading. Are they making profits or going into losses? The whole scenario will be ambiguous. There will be no direction and no goal. The employees will work aimlessly just because they have to work in order to earn. Such companies are destined to drown someday. Another disadvantage or drawback of not having an “Income statement” is that in situations where the company will need funds, it will have to approach a bank or any financial institution. The first document that shall be asked for is the “Income statement”. Without this, neither any bank nor any financial institution will entertain that company. Another disadvantage is that investors will never invest in the company’s debentures and shares. Looking to all these aspects, it is understood that the future of that company shall be doomed.
In concluding this paper, it is evident that “Income statement” is a must for any company which wants to progress. It comes in handy for both – internal and external uses. Internal means for the management and external means for the investors and financial institutions. In my opinion, “Income Statement” should be made mandatory even for individuals. To some extent the black marketing will be curtailed.
Beerbohm Max. “Quotations about Money”. 2011. Web.
Eisenberg Henry. “Henry Eisenberg quotes.” 2011. Web.
Evans Donald. “Donald Evans quotes.” 2011. Web.
Franklin Benjamin. “Benjamin Franklin quotes.” 2011. Web.
Graham, Dodd, Cottle, Murray, Block. Graham and Dodd’s security analysis. United States of America: McGraw-Hill Professional. 01-Jan-1988. Print.